McGraw-Hill/Irwin1 © The McGraw-Hill Companies, Inc., 2006

22-1

Cost-Volume-Profit Analysis

Chapter

2222

McGraw-Hill/Irwin2 © The McGraw-Hill Companies, Inc., 2006

22-2

CVP analysis is used to answer questionssuch as:• How much must I sell to earn my desired income?

• How will income be affectedif I reduce selling prices toincrease sales volume?

• How will income be affectedif I change the sales mixof my products?

CVP analysis is used to answer questionssuch as:• How much must I sell to earn my desired income?

• How will income be affectedif I reduce selling prices toincrease sales volume?

• How will income be affectedif I change the sales mixof my products?

Questions Addressed byCost-Volume-Profit AnalysisQuestions Addressed byCost-Volume-Profit Analysis

McGraw-Hill/Irwin3 © The McGraw-Hill Companies, Inc., 2006

22-3

Number of Local Calls

Mon

thly

Bas

ic

Tel

epho

ne B

ill

Total fixed costs remain unchangedwhen activity changes.

Your monthly basictelephone bill probablydoes not change when

you make more local calls.

Total Fixed CostTotal Fixed Cost

McGraw-Hill/Irwin4 © The McGraw-Hill Companies, Inc., 2006

22-4

Number of Local Calls

Mon

thly

Bas

ic T

elep

hone

B

ill p

er L

ocal

Cal

l

Fixed costs per unit declineas activity increases.

Your average cost perlocal call decreases as

more local calls are made.

Fixed Cost Per UnitFixed Cost Per Unit

McGraw-Hill/Irwin5 © The McGraw-Hill Companies, Inc., 2006

22-5

Minutes Talked

Tot

al L

ong

Dis

tanc

eT

elep

hone

Bill

Total variable costs changewhen activity changes.

Your total long distancetelephone bill is basedon how many minutes

you talk.

Total Variable CostTotal Variable Cost

McGraw-Hill/Irwin6 © The McGraw-Hill Companies, Inc., 2006

22-6

Minutes Talked

Per

Min

ute

Tel

epho

ne C

harg

e

Variable costs per unit do not changeas activity increases.

The cost per long distanceminute talked is constant.

For example, 7cents per minute.

Variable Cost Per UnitVariable Cost Per Unit

McGraw-Hill/Irwin7 © The McGraw-Hill Companies, Inc., 2006

22-7

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Variable Changes as activity level

changes.Remains the same over wide

ranges of activity.

FixedRemains the same even

when activity level changes.Decreases as activity level

increases.

Cost Behavior SummaryCost Behavior Summary

McGraw-Hill/Irwin8 © The McGraw-Hill Companies, Inc., 2006

22-8

Mixed costs contain a fixed portion that is incurred even when facility is unused, and a variable portion that increases with usage.

Example: monthly electric utility charge

• Fixed service fee

• Variable charge perkilowatt hour used

Mixed CostsMixed Costs

McGraw-Hill/Irwin9 © The McGraw-Hill Companies, Inc., 2006

22-9

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

Total mixed cost

Fixed Monthly

Utility Charge

Mixed CostsMixed Costs

McGraw-Hill/Irwin10 © The McGraw-Hill Companies, Inc., 2006

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Activity

Co

st

Total cost remainsconstant within anarrow range of

activity.

Step-Wise CostsStep-Wise Costs

McGraw-Hill/Irwin11 © The McGraw-Hill Companies, Inc., 2006

22-11

Activity

Co

st

Total cost increases to a new higher cost for the

next higher range of activity.

Step-Wise CostsStep-Wise Costs

McGraw-Hill/Irwin12 © The McGraw-Hill Companies, Inc., 2006

22-12

Costs that increase when activity increases, but in a nonlinear manner.

Activity

To

tal

Co

st

Curvilinear CostsCurvilinear Costs

McGraw-Hill/Irwin13 © The McGraw-Hill Companies, Inc., 2006

22-13

The objectiveis to classify all costs as

either fixed or variable.

Identifying and MeasuringCost BehaviorIdentifying and MeasuringCost Behavior

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22-14

A scatter diagram of past cost behavior may be helpful in analyzing mixed costs.

Scatter DiagramScatter Diagram

McGraw-Hill/Irwin15 © The McGraw-Hill Companies, Inc., 2006

22-15

Plot the data points on a graph (total cost vs. activity).

0 1 2 3 4

*

To

tal

Co

st i

n1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units Produced

Scatter DiagramScatter Diagram

McGraw-Hill/Irwin16 © The McGraw-Hill Companies, Inc., 2006

22-16

Draw a line through the plotted data points so that about equal numbers of points fall above and below the line.

Estimated fixed cost = 10,000

0 1 2 3 4

*

To

tal

Co

st i

n1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units Produced

Scatter DiagramScatter Diagram

McGraw-Hill/Irwin17 © The McGraw-Hill Companies, Inc., 2006

22-17

Vertical distance

is the change in cost.

Horizontal distance is the change in activity.

Unit Variable Cost = Slope = in costin units

0 1 2 3 4

*

To

tal

Co

st i

n1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units Produced

Scatter DiagramScatter Diagram

McGraw-Hill/Irwin18 © The McGraw-Hill Companies, Inc., 2006

22-18

The following relationships between salesand costs are observed:

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.

Sales Cost

High activity level 67,500$ 29,000$ Low activity level 17,500 20,500 Change 50,000$ 8,500$

The High-Low MethodThe High-Low Method Exh. 22-6

McGraw-Hill/Irwin19 © The McGraw-Hill Companies, Inc., 2006

22-19

Unit variable cost = = = $0.17 per $in costin units

$8,500$50,000

Sales Cost

High activity level 67,500$ 29,000$ Low activity level 17,500 20,500 Change 50,000$ 8,500$

The High-Low MethodThe High-Low Method Exh. 22-6

McGraw-Hill/Irwin20 © The McGraw-Hill Companies, Inc., 2006

22-20

Sales Cost

High activity level 67,500$ 29,000$ Low activity level 17,500 20,500 Change 50,000$ 8,500$

Unit variable cost = = = $0.17 per $

Fixed cost = Total cost – Total variable

in costin units

$8,500$50,000

The High-Low MethodThe High-Low Method Exh. 22-6

McGraw-Hill/Irwin21 © The McGraw-Hill Companies, Inc., 2006

22-21

Sales Cost

High activity level 67,500$ 29,000$ Low activity level 17,500 20,500 Change 50,000$ 8,500$

Unit variable cost = = = $0.17 per $

Fixed cost = Total cost – Total variable cost

Fixed cost = $29,000 – ($0.17 per sales $ × $67,500)

Fixed cost = $29,000 – $11,475 = $17,525

in costin units

$8,500$50,000

The High-Low MethodThe High-Low Method Exh. 22-6

McGraw-Hill/Irwin22 © The McGraw-Hill Companies, Inc., 2006

22-22

The objective of the cost analysis remains the

same: determination of total fixed cost and the

variable unit cost.

Least-squares regression is usually covered in advanced cost accounting courses. It is

commonly used with computer software because of the large number of

calculations required.

Least-Squares RegressionLeast-Squares Regression

McGraw-Hill/Irwin23 © The McGraw-Hill Companies, Inc., 2006

22-23

Let’s extend our

knowledge of

cost behavior to

break-even analysis.

Break-Even AnalysisBreak-Even Analysis

McGraw-Hill/Irwin24 © The McGraw-Hill Companies, Inc., 2006

22-24

The break-even point (expressed in units of product or dollars of sales) is the

unique sales level at which a company earns neither a profit nor incurs a loss.

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin25 © The McGraw-Hill Companies, Inc., 2006

22-25

Contribution margin is amount by which revenue exceeds the variable costs of producing the revenue.

Contribution margin is amount by which revenue exceeds the variable costs of producing the revenue.

Total Unit

Sales Revenue (2,000 units) 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin26 © The McGraw-Hill Companies, Inc., 2006

22-26

Total Unit

Sales Revenue (2,000 units) 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

How much contribution margin must this company have to cover its fixed costs (break even)?

Answer: $30,000

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin27 © The McGraw-Hill Companies, Inc., 2006

22-27

How many units must this company sell to cover its fixed costs (break even)?

Total Unit

Sales Revenue (2,000 units) 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

Answer: $30,000 ÷ $20 per unit = 1,500 units

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin28 © The McGraw-Hill Companies, Inc., 2006

22-28

We have just seen one of the basic CVP relationships – the break-even computation.

Break-even point in units = Fixed costs

Contribution margin per unit

Computing Break-Even PointComputing Break-Even Point

Unit sales price less unit variable cost($20 in previous example)

Exh. 22-8

McGraw-Hill/Irwin29 © The McGraw-Hill Companies, Inc., 2006

22-29

The break-even formula may also be expressed in sales dollars.

Break-even point in dollars = Fixed costs

Contribution margin ratio

Unit contribution margin Unit sales price

Computing Break-Even PointComputing Break-Even Point Exh. 22-9

McGraw-Hill/Irwin30 © The McGraw-Hill Companies, Inc., 2006

22-30

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin31 © The McGraw-Hill Companies, Inc., 2006

22-31

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

Unit contribution = $5.00 - $3.00 = $2.00

Fixed costsUnit contribution =

$200,000$2.00 per unit

= 100,000 units

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin32 © The McGraw-Hill Companies, Inc., 2006

22-32

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin33 © The McGraw-Hill Companies, Inc., 2006

22-33

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Unit contribution = $5.00 - $3.00 = $2.00

Contribution margin ratio = $2.00 ÷ $5.00 = .40

Break-even revenue = $200,000 ÷ .4 = $500,000

Computing Break-Even PointComputing Break-Even Point

McGraw-Hill/Irwin34 © The McGraw-Hill Companies, Inc., 2006

22-34

Volume in Units

Co

sts

and

Rev

enu

ein

Do

llar

s Total fixed costsTotal costs

Draw the total cost line with a slopeequal to the unit variable cost.

Plot total fixed costs on the vertical axis.

Preparing a CVP ChartPreparing a CVP Chart

McGraw-Hill/Irwin35 © The McGraw-Hill Companies, Inc., 2006

22-35

Sales

Volume in Units

Co

sts

and

Rev

enu

ein

Do

llar

s Starting at the origin, draw the sales line with a slope equal to the unit sales price.

Preparing a CVP ChartPreparing a CVP Chart

Break-even Point

Total costsTotal fixed costs

McGraw-Hill/Irwin36 © The McGraw-Hill Companies, Inc., 2006

22-36

A limited range of activity called the relevant range, where CVP relationships are linear. Unit selling price remains constant.

Unit variable costs remain constant.

Total fixed costs remain constant.

Production = sales (no inventory changes).

Assumptions of CVP AnalysisAssumptions of CVP Analysis

McGraw-Hill/Irwin37 © The McGraw-Hill Companies, Inc., 2006

22-37

Income (pretax) = Sales – Variable costs – Fixed costsIncome (pretax) = Sales – Variable costs – Fixed costs

Computing Income from Expected SalesComputing Income from Expected Sales Exh.

22-12

McGraw-Hill/Irwin38 © The McGraw-Hill Companies, Inc., 2006

22-38

Rydell expects to sell 1,500 units at $100 each next month. Fixed costs are $24,000 per

month and the unit variable cost is $70. What amount of income should Rydell expect?

Income (pretax) = Sales – Variable costs – Fixed costs

= [1,500 units × $100] – [1,500 units × $70] – $24,000

= $21,000

Income (pretax) = Sales – Variable costs – Fixed costs

= [1,500 units × $100] – [1,500 units × $70] – $24,000

= $21,000

Computing Income from Expected SalesComputing Income from Expected Sales Exh.

22-13

McGraw-Hill/Irwin39 © The McGraw-Hill Companies, Inc., 2006

22-39

Break-even formulas may be adjusted to show the sales volume needed to earn

any amount of income.

Break-even formulas may be adjusted to show the sales volume needed to earn

any amount of income.

Unit sales = Fixed costs + Target incomeContribution margin per unit

Dollar sales = Fixed costs + Target income

Contribution margin ratio

Computing Sales for a Target IncomeComputing Sales for a Target Income

McGraw-Hill/Irwin40 © The McGraw-Hill Companies, Inc., 2006

22-40

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to earn income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to earn income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units

Computing Sales for a Target IncomeComputing Sales for a Target Income

McGraw-Hill/Irwin41 © The McGraw-Hill Companies, Inc., 2006

22-41

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to earn income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be

sold to earn income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units = 120,000 units

Unit contribution = $5.00 - $3.00 = $2.00

Fixed costs + Target income Unit contribution

$200,000 + $40,000 $2.00 per unit

Computing Sales for a Target IncomeComputing Sales for a Target Income

McGraw-Hill/Irwin42 © The McGraw-Hill Companies, Inc., 2006

22-42

Target net income is income after income tax.Target net income is income after income tax.

Dollar sales =

Fixed Target net Incomecosts income taxes

Contribution margin ratio

+ +

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income Exh.

22-14

McGraw-Hill/Irwin43 © The McGraw-Hill Companies, Inc., 2006

22-43

To convert target net income to before-tax income, use the following formula:

Before-tax income = Target net income

1 - tax rate

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income

McGraw-Hill/Irwin44 © The McGraw-Hill Companies, Inc., 2006

22-44

Rydell has a monthly target net income of $18,000. The unit selling price is $100. Monthly fixed costs are $24,000, the unit variable cost is $70, and the tax rate is 25 percent.

What is Rydell’s before-tax income andincome tax expense?

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income

McGraw-Hill/Irwin45 © The McGraw-Hill Companies, Inc., 2006

22-45

Before-tax income = Target net income

1 - tax rate

Before-tax income = = $24,000$18,000

1 - .25

Income tax = .25 × $24,000 = $6,000

Rydell has a monthly target net income of $18,000. The unit selling price is $100. Monthly fixed costs are $24,000, the unit variable cost is $70, and the tax rate is 25 percent.

What is Rydell’s before-tax income andincome tax expense?

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income

McGraw-Hill/Irwin46 © The McGraw-Hill Companies, Inc., 2006

22-46

Rydell has a monthly target net income of $18,000. The unit selling price is $100. Monthly fixed costs are $24,000, the unit variable cost is $70, and the tax rate is 25 percent.

What monthly sales revenue will Rydellneed to earn the target net income?

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income

McGraw-Hill/Irwin47 © The McGraw-Hill Companies, Inc., 2006

22-47

Dollar sales =

Fixed Target net Incomecosts income taxes

Contribution margin ratio

+ +

Dollar sales = = $160,000

$24,000 + $18,000 + $6,00030%

Rydell has a monthly target net income of $18,000. The unit selling price is $100. Monthly fixed costs are $24,000, the unit variable cost is $70, and the tax rate is 25 percent.

What monthly sales revenue will Rydellneed to earn the target net income?

Computing Sales (Dollars) for aTarget Net IncomeComputing Sales (Dollars) for aTarget Net Income

McGraw-Hill/Irwin48 © The McGraw-Hill Companies, Inc., 2006

22-48

The formula for computing dollar sales may be used to compute unit sales by substituting contribution per unit in the denominator.

The formula for computing dollar sales may be used to compute unit sales by substituting contribution per unit in the denominator.

Contribution margin per unitUnit sales =

Fixed Target net Incomecosts income taxes

+ +

Unit sales = = 1,600 units$24,000 + $18,000 + $6,000

$30 per unit

Formula for Computing Sales (Units)for a Target Net IncomeFormula for Computing Sales (Units)for a Target Net Income Exh.

22-16

McGraw-Hill/Irwin49 © The McGraw-Hill Companies, Inc., 2006

22-49

Margin of safety is the amount by which sales may decline before reaching break-

even sales.

Margin of safety may be expressed as a percentage of expected sales.

Computing the Margin of SafetyComputing the Margin of Safety Exh. 22-17

Margin of safety Expected sales - Break-even sales percentage Expected sales

=

McGraw-Hill/Irwin50 © The McGraw-Hill Companies, Inc., 2006

22-50

Margin of safety Expected sales - Break-even sales percentage Expected sales

=

If Rydell’s sales are $100,000 and break-even sales are $80,000, what is the margin of safety in dollars and as a percentage?

Computing the Margin of SafetyComputing the Margin of Safety Exh. 22-17

McGraw-Hill/Irwin51 © The McGraw-Hill Companies, Inc., 2006

22-51

If Rydell’s sales are $100,000 and break-even sales are $80,000, what is the margin of safety in dollars and as a percentage?

Margin of safety = $100,000 - $80,000 = $20,000

Margin of safety Expected sales - Break-even sales percentage Expected sales

=

Margin of safety $100,000 - $80,000 percentage $100,000

= = 20%

Computing the Margin of SafetyComputing the Margin of Safety Exh. 22-17

McGraw-Hill/Irwin52 © The McGraw-Hill Companies, Inc., 2006

22-52

The basic CVP relationships may be used to analyze a number of situations such as changing sales price, changing variable

cost, or changing fixed cost.

Consider the following example.

The basic CVP relationships may be used to analyze a number of situations such as changing sales price, changing variable

cost, or changing fixed cost.

Consider the following example.

Continue

Sensitivity AnalysisSensitivity Analysis

McGraw-Hill/Irwin53 © The McGraw-Hill Companies, Inc., 2006

22-53

Rydell Company is considering buying a new machine that would increase monthly fixed costs

from $24,000 to $30,000, but decrease unit variable costs from $70 to $60. The $100 per unit selling price would remain unchanged.

What is the new break-even point in dollars?

Sensitivity Analysis ExampleSensitivity Analysis Example

McGraw-Hill/Irwin54 © The McGraw-Hill Companies, Inc., 2006

22-54

Rydell Company is considering buying a new machine that would increase monthly fixed costs

from $24,000 to $30,000, but decrease unit variable costs from $70 to $60. The $100 per unit selling price would remain unchanged.

Revised Break-evenpoint in dollars

Revised fixed costsRevised contribution margin ratio

Revised Break-evenpoint in dollars

$30,00040%

= $75,000=

=

Sensitivity Analysis ExampleSensitivity Analysis Example Exh. 22-18

McGraw-Hill/Irwin55 © The McGraw-Hill Companies, Inc., 2006

22-55

The CVP formulas may be modified for use when a company sells more than one product. • The unit contribution margin is replaced with the

contribution margin for a composite unit.

• A composite unit is composed of specific numbers of each product in proportion to the product sales mix.

• Sales mix is the ratio of the volumes of the various products.

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point

McGraw-Hill/Irwin56 © The McGraw-Hill Companies, Inc., 2006

22-56

The resulting break-even formulafor composite unit sales is:

Break-even pointin composite units

Fixed costsContribution marginper composite unit

=

Consider the following example:

Continue

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point Exh.

22-19

McGraw-Hill/Irwin57 © The McGraw-Hill Companies, Inc., 2006

22-57

Hair-Today offers three cuts as shown below. Annual fixed costs are $96,000. Compute the break-even point in composite units and in number of units for

each haircut at the given sales mix.

Haircuts Basic Ultra Budget

Selling Price 10.00$ 16.00$ 8.00$ Variable Cost 6.50 9.00 4.00 Unit Contribution 3.50$ 7.00$ 4.00$ Sales Mix Ratio 4 2 1

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point

McGraw-Hill/Irwin58 © The McGraw-Hill Companies, Inc., 2006

22-58

Hair-Today offers three cuts as shown below. Annual fixed costs are $96,000. Compute the break-even point in composite units and in number of units for

each haircut at the given sales mix.

Haircuts Basic Ultra Budget

Selling Price 10.00$ 16.00$ 8.00$ Variable Cost 6.50 9.00 4.00 Unit Contribution 3.50$ 7.00$ 4.00$ Sales Mix Ratio 4 2 1

A 4:2:1 sales mix means that if there are 500 budget cuts, then there will be

1,000 ultra cuts, and 2,000 basic cuts.

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point

McGraw-Hill/Irwin59 © The McGraw-Hill Companies, Inc., 2006

22-59

HaircutsBasic Ultra Budget

Selling Price $10.00 $16.00 $8.00Variable Cost 6.50 9.00 4.00 Unit Contribution $3.50 $7.00 $4.00Sales Mix Ratio × 4 × 2 × 1

14.00$ 14.00$ 4.00$

Step 1: Compute contribution margin per composite unit.

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point

McGraw-Hill/Irwin60 © The McGraw-Hill Companies, Inc., 2006

22-60

HaircutsBasic Ultra Budget

Selling Price $10.00 $16.00 $8.00Variable Cost 6.50 9.00 4.00 Unit Contribution $3.50 $7.00 $4.00Sales Mix Ratio × 4 × 2 × 1Weighted Contribution 14.00$ + 14.00$ + 4.00$ = 32.00$

Contribution margin per composite unit

Step 1: Compute contribution margin per composite unit.

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point

McGraw-Hill/Irwin61 © The McGraw-Hill Companies, Inc., 2006

22-61

Break-even pointin composite units

Fixed costsContribution marginper composite unit

=

Step 2: Compute break-even point in composite units.

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point Exh.

22-19

McGraw-Hill/Irwin62 © The McGraw-Hill Companies, Inc., 2006

22-62

Break-even pointin composite units

Fixed costsContribution marginper composite unit

=

Step 2: Compute break-even point in composite units.

Break-even pointin composite units

$96,000$32.00 per

composite unit

=

Break-even pointin composite units

= 3,000 composite units

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point Exh.

22-19

McGraw-Hill/Irwin63 © The McGraw-Hill Companies, Inc., 2006

22-63

Sales CompositeProduct Mix Cuts Haircuts

Basic 4 × 3,000 = 12,000Ultra 2 × 3,000 = 6,000

Budget 1 × 3,000 = 3,000

Step 3: Determine the number of each haircut that must be sold to break even.

Computing MultiproductBreak-Even PointComputing MultiproductBreak-Even Point

McGraw-Hill/Irwin64 © The McGraw-Hill Companies, Inc., 2006

22-64

HaircutsBasic Ultra Budget Combined

Selling Price 10.00$ 16.00$ 8.00$ Variable Cost 6.50 9.00 4.00 Unit Contribution 3.50$ 7.00$ 4.00$ Sales Volume × 12,000 × 6,000 × 3,000 Total Contribution 42,000$ 42,000$ 12,000$ 96,000$

Fixed Costs 96,000 Income $ 0

Step 4: Verify the results.

Multiproduct Break-EvenIncome StatementMultiproduct Break-EvenIncome Statement Exh.

22-20

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A measure of the extent to which fixed costsare being used in an organization.

A measure of the extent to which fixed costsare being used in an organization.

A measure of how a percentage change in sales will affect profits.

A measure of how a percentage change in sales will affect profits.

Contribution margin Net income

= Degree of operating leverage

Operating LeverageOperating Leverage

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Rydell Company

Sales (1,600 units) 160,000$ Less: variable expenses 112,000 Contribution margin 48,000 Less: fixed expenses 24,000 Net income 24,000$

$48,000 $24,000

= 2.0

Contribution margin Net income

= Degree of operating leverage

If Rydell increases sales by 10percent, what will the percentage

increase in income be?

Operating LeverageOperating Leverage

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Percent increase in sales 10%

Degree of operating leverage × 2

Percent increase in income 20%

Operating LeverageOperating Leverage

Rydell Company

Sales (1,600 units) 160,000$ Less: variable expenses 112,000 Contribution margin 48,000 Less: fixed expenses 24,000 Net income 24,000$

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Homework for Chapter 22Homework for Chapter 22

Ex 22-6, 22-9, 22-11, 22-13, 22-14 Problem 22-3A, 22-5A, 22-6A

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End of Chapter 22End of Chapter 22